The dollar index was largely steady at around 91.25 on Thursday, while sterling/dollar traded above the 1.39 mark. Spot gold was steady at $1,787 an ounce. Investors are bracing for a BoE decision this trading day, which is the second most important risk event of the week after the non-farm report. The BoE is widely expected to keep monetary policy on hold, but sterling against the dollar could rise sharply after the decision if it sends an important signal of tapering.
The Bank of England is expected to signal a tapering of its bond purchases
At 19:00 Hong Kong time on Thursday, the Bank of England (BoE) will release the interest rate decision, minutes and monetary policy report. The Bank of England is expected to keep interest rates unchanged at 0.10 percent and its monthly bond purchases unchanged on Thursday. The Bank of England is likely to raise its forecast for economic growth this year.
The likelihood that the Bank of England will scale back its stimulus measures is increasing as the economy recovers from the new pandemic. Many in the market are speculating that the Bank of England will start discussing how and when to withdraw stimulus.
The Bank of England is expected to signal this week that it will soon be ready to tighten monetary policy as the outlook for the UK economy proves brighter than expected earlier this year and inflation rises, Barron’s said on Wednesday.
The Barron’s article points out that the BoE has a strong case to start talking about tightening policy, as the government’s road map to ease the two-month blockade has not suffered major problems since the BoE’s last meeting, and the Coronavirus vaccination campaign has continued unabated. At the same time, fiscal stimulus remains strong, with the government continuing to support households and businesses by extending last year’s measures or implementing new ones. This week, the Bank of England’s own economic forecasts should follow the upward revision of other institutions or analysts’ growth forecasts and downward revisions to unemployment.
Analysts do not expect the Bank of England to change its key interest rate, currently at 0.1 per cent, this year or next, while markets expect only two increases from 2023. But the Bank of England must decide on its bond-buying programme. If the current pace of weekly bond purchases is maintained, the program could end before the end of December.
Bloomberg researchers expect the Bank of England’s monetary policy committee to vote unanimously to keep policy unchanged on Thursday. This left the BoE’s policy rate on hold at 0.1 per cent and the target for the total asset purchase programme unchanged at £895bn.
Indeed, speculation about tapering and slowing the pace of bond-buying has picked up steam since the BoE published its latest forecasts in early February. Dan Hanson, an economist, said the slower pace of bond-buying meant the Bank of England’s growth forecast for the UK economy this year would be sharply revised upwards. But with the economic recovery still in its infancy, the BoE is likely to stress that the threshold for tightening policy is higher than usual and that it is prepared to ease the bond-buying restrictions again if necessary.
Citi believes that the Bank of England is likely to signal a technical taper.
Analysts at ING noted that markets were pricing in weaker BoE support in the coming months.
Daiwa Capital said the BoE’s decision would be accompanied by updated economic forecasts, which were likely to reflect data “substantially stronger than the MPC’s latest forecasts published in February”.
Kathy Lien, currency strategist at BK Asset Management, wrote on Wednesday that the BoE’s monetary policy release due on Thursday is the second most important event of the week, after Friday’s non-farm payrolls report. Like the RBA, the BoE is widely expected to keep policy unchanged. The chances of tapering are small, but the chances of an upward revision of economic forecasts are very high.
Lien writes: “There is much to be optimistic about at the Bank of England. The UK leads the developed world in vaccination, with more than half the population having received at least one dose of COVID-19 vaccine. The number of new coronavirus cases per day has dropped below 2,000 compared to 68,000 reported on January 8, which is a huge improvement. The British economy is ready to end all blockade restrictions on June 21st. Restaurants, bars and gyms have been open for weeks and the UK economy is starting to benefit, with the PMI index rising to its highest level in 89 months. When the UK is fully opened up, we will see greater momentum for growth.”
Sterling expected to strengthen after BoE decision
Even if the BoE keeps monetary policy on hold, sterling/dollar is set to rise strongly post-decision and could even rise to the 1.40 level if the central bank sends an important signal of tapering, with the possibility of a surprise announcement, analysts said.
“The overall picture of the UK economy has become clear that tapering is inevitable and it is now just a matter of timing,” Deutsche Bank analysts including Sanjay Raja said in a note.
Analysts at Brown Brothers Harriman expect the BoE to take a hawkish stance. Interest rates are expected to remain steady, but the central bank may start to taper asset purchases. At its last meeting, on March 18, the BoE did not seem unduly concerned by the rise in gilt yields, noting that “overall indicators of UK financial conditions have been little changed since the February report”. Since then, gilt yields have remained largely unchanged, so concerns are likely to remain low. Sterling tends to strengthen on BoE decision days.
For Thursday’s BoE policy meeting, the Bank of America expects the BoE to confirm market expectations for two rate rises by the end of 2024 and reduce the size of its quantitative easing purchases, if not this week, then at its next meeting in June. The bank believes the risk of a more hawkish BoE should support sterling.
Parisha Saimbi, strategist at BNP Paribas, said sterling was less risky ahead of Thursday’s policy meeting as a lot of positive news had already been priced in, but if it weakened it would be a good time to enter. BNP Paribas is bullish on sterling in the medium term and sees the fall as a buying opportunity, mainly because of expected inflows into UK domestic equities as the economy recovers.
HSBC said it was ready for the Bank of England to announce a slowdown in the pace of bond purchases at its upcoming meeting this week. If the Bank of England announces a taper, even a small one, it is expected to be a significant policy shift that would boost sterling. In addition, discussions on the Bank of England’s tapering may be imminent, perhaps this week or before its June meeting.
“With sterling strongly supported on the upside by the weaker dollar environment, combined with the UK’s faster vaccination pace, the outcome of this week’s UK rate decision could be further positive for sterling,” Petr Krpata, strategist at ING, wrote in a note to clients.
George Vessey, strategist at Western Union Business Solutions, said sterling could rise this week if the Bank of England signals in its monetary policy statement on Thursday that it will start tapering its bond-buying program.
Kathy Lien, an analyst at BK Asset Management, noted that while the BoE had predicted a recovery, it was stronger than expected because of the speed with which the government had succeeded in vaccinating more than half the population. Combined with the strong recovery in the US and the inevitable reopening of the eurozone, the outlook for the UK economy is now clearer and brighter than the latest forecasts published in February. As well as revising up the economic forecasts, we expect the BoE to prepare the ground for a summer taper, which should rekindle sterling gains.
Sterling has been on an upward trend over the past six months and these gains reflect investors’ expectations that the Bank of England will be less dovish, she said. There is no doubt that the Bank of England will taper before the Fed and will probably be the first to raise interest rates. So unless the BoE statement is fraught with concern, or the BoE avoids an upward assessment of the economy, which is unlikely, GBP/USD should move higher after the announcement.